The Retirement Puzzle

Someone asked me how I felt when I handed in my retirement notice.

Well, it felt a lot like I was quitting.

I suppose putting in a retirement notice is similar to quitting. Except that there is no next job on the horizon. And, because I presently serve as a senior executive in an Insurance company, I can’t just give a couple of weeks notice. In my case, I have provided 9 months notice to allow the CEO time for an orderly transition.

So, although my intentions are clear, I still have a few months left before I am officially retired.

We have been planning for retirement for years now, and yet there are a few questions that continue to worry me:

• Will we have enough money?
• Will we be happy?
• Will we stay healthy?

Being a numbers guy, I have been preoccupied with the first question. This is probably the most common question that people have when they think about retirement: how much money will I need to retire well?

Keep in mind that I am offering a Canadian perspective. The U.S. is a very different country in terms of asset and income variance. To enter the top 1 percent of income in Canada is roughly $225,000 a year. In the U.S. the entry point is almost $600,000 Canadian a year. And in Canada, there are only about 300,000 tax filers in this category.

A recent poll issued by BMO Harris Private Banking, claims that people with at least $1 million of investable assets think they need $2.3 million to retire well. Canadians with at least $1 million of investable assets reflect only 1 percent of the population. Most Canadians will never be able to accumulate that much money for retirement.

Ask most Canadians the same question, and they might say $1 million. Or less. Or more. Very few have a clear idea of what is needed.

My approach was very straightforward. I tracked all of my expenses and I categorized them. I had two columns: one for my expenses while working and one for expenses that we would carry on into retirement. I then looked at contributions from pensions and identified the gap. That gap represented the target retirement savings that I thought I should have before I could call a retirement date. And, of course, there could be no outstanding debt carried into retirement.

Let’s take an example.

We will assume a household with only one income earner and let’s assume that single income earner is doing okay. Much better than the average.

In my province of Ontario, income at the 50th percentile — the median where half make less and half make more — is just under $40,000. Yes, you read that correctly, $40,000. Income at the 75th percentile is $72,000 and at the 90th percentile it is $110,000.

Let’s use that number.

Our single income earner, roughly 10 years from retirement, will pay about $30,000 in taxes on $110,000 of income. That leaves him with $80,000 to spend.

He holds a mortgage which costs him $18,000 a year. This assumes that he put 20% down on an average house and he carries the balance as a mortgage that is paid down over 25 years. The house would be worth about $400,000.

So, he is now left with $62,000 to spend after taxes and mortgage. Out of that amount, he has a number of expenses to cover: cars, food, entertainment, raising kids, saving for retirement. Which, if we look at the average household expenditure after tax, means he has very little, if anything, left over.

But, what might his expenses look like after retirement?

His mortgage would be gone. Saving for retirement would be done. Money spent on raising the kids would be done (hopefully).

In all likelihood, he would be able to live to the same standard in retirement at roughly 60% of his pre-retirement income. Indeed, Sun Life completed a report where they found that the average retired Canadian was living quite well on 62% of what they earned before leaving work. That ratio goes down as income goes up. One of the few benefits of a highly progressive taxation system in Canada is that high income earners can likely live quite well on much less, say 35 to 50% of their pre-retirement income.

So let’s see where our single income earner might stand.

This is what he can count on in retirement. Assuming that he intends to maintain his standard of living, he would need to achieve about $68,200 per year. Based on averages, he might see the following:

CPP: $8,000
OAS: $14,000 (for both himself and his spouse)
Pension: $45,000

Well, lucky fellow! He is almost there at $67,000. His gap is really only a few thousand. Let’s say he needs $10,000 more per year, a total of $77,000 to fill the gap and provide some buffer. A simple way to calculate his target retirement savings is to multiply $10,000 by 25: $250,000. If invested appropriately, he should be able to take out 4% in the first year and then increase his withdrawal by the inflation rate in subsequent years.

If our single income earner did not have a great pension, let’s say only $25,000 then his gap would be $30,000 which would mean a target retirement savings of $750,000. That amount of savings is a pretty big number for most Canadians. Let’s hope he understood the need to put money aside during his working career! Although, as some financial planners would say, you will have whatever you have when retirement comes along. If you are within a few years, there is not much you can do except try to work longer and accept a lower standard of living whenever retirement happens.

The most recent data from Statistics Canada shows families whose highest income earner was 65 or older, had a median after-tax income of $57,500 in 2015. Our single income earner in our example will be taking in more than that in retirement and he will likely enjoy more discretionary spending now that the kids have gone and the house has been paid off.

Every person will have a unique situation in terms of how much is enough money for retirement. From all of the reading and research I have done in this area, I have reached a few basic conclusions:

We will live on much less in retirement because our income taxes will be substantially lower. We can easily live to the same standard on an after-tax basis with an income replacement ratio of 45%.

Thank heavens I set money aside when I was younger. That is the only reason why I can retire earlier at 61 as opposed to 65. Fortunately I have always worked for companies with defined benefit pension plans. Although not indexed for inflation, they are worth a lot of money to me in retirement. To get a rough idea, I took the annual income stream from my pensions, multiplied it by 25 years — I hope to live that much longer! — and gained a deep appreciation for 35 years of pension contributions. I also set a lot of money aside in my 40s which gave time for my investments to grow over the following two decades. That combination of company pension plans and personal investments provides the foundation for financial independence.

Having enough is a very personal matter and in the long run doesn’t mean very much. Having enough to not worry about money is probably the best perspective. As I have done my own research, most people in retirement do not consume like they did in their younger years. They value time and relationships. They find purpose differently from when they were working.

Lorraine keeps telling me not to worry about the numbers.

We have enough.

So. Will we be happy? Will we be healthy?

More on those two questions later.